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Delhi’s underbelly

1 November 2011 By Jeff Glekin

India is set to bust its fiscal deficit to GDP target. Half way through the year, it has used two-thirds of the sums set aside. With inflation close to 10 percent and growth sluggish, there is an urgent need for the government to get a grip of public spending.

India’s finance minister, Pranab Mukerjee, does have a lot on his plate. But only with economic growth can he afford to help rural voters through fuel subsidies, food handouts and employment guarantees. Only with growth, for instance, can he justify the four-fold surge in expenditure under the National Rural Employment Guarantee Act of 2005. Only with growth is it sustainable to take decisions such as the one which saw the government raise minimum support prices of key winter crops by 15 to 39 percent.

Without sufficient growth, moreover, the measures might only serve to raise demand without increasing supply – and that would make inflation worse.

Interest rates have been increased no fewer than 13 times since March 2010, but loose public spending undermines the central bank’s efforts to keep the lid on prices. And while rate hikes are having only a muted impact on inflation, they raise the cost of borrowing for Indian business. This, in turn, has led to reduced investment and slower growth.

As things stand, New Delhi cannot afford the handouts and subsidies. A quick fix would be to sell stakes in state owned businesses. This would have the benefit of raising cash for the finance ministry, reducing its need to borrow from the market. It would also send a positive signal to the private sector that the state was reducing its control over the economy.

But ultimately, India may require a dose of austerity and further economic reforms. Politicians fear the loss of support of key voters if the handouts are taken away. But the same voters will suffer from sky-high inflation and sluggish growth. They will be thankful if tighter fiscal policy leads to lower inflation and spurs economic growth back towards 9 percent. It’s only sustainable growth that will improve standards of living across the subcontinent.

 

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